Fed’s exit strategy was designed by Peter Pan, former central bank economist says

The Federal Reserve’s exit strategy is so unrealistic it seems to have been designed by Peter Pan from Neverland, said Vincent Reinhart, chief U.S. economist at Morgan Stanley and former top U.S. central bank staffer.

“Peter Pan’s advice was to think of an impossible thing each morning. FOMC members have presumably been following this advice since their September meeting,” Reinhart wrote in a scathing note.

Reinhart said the Fed’s impossible thing is how they think they can raise interest rates with a big balance sheet without embracing its new tool – overnight reverse repo trades.

The Fed placed a $300 billion cap on volume of reverse repo trades. A reverse repo is when the Fed accepts cash from counterparties such as banks and money-market funds on an overnight basis in return for a security.

But the Fed doesn’t seem to want to want to make the reverse repo facility very large, wary of its market impact.

“If they don’t sell assets or drain them on a temporary basis in large scale, then the volume of reserves in the banking system will undermine the reserves market. They cannot have both small reverse repos and a meaningful effective funds rate,” Reinhart said in a follow-up email.

“When the FOMC returns from Neverland, we will hear about the choice,” he said in his note.